Stock Market Asset Question 2022

Exam pdf 1

Exam PDF 1
Part 1: d : This is because the small stock is considered risky among the equity asset class
which is due to lack in liquidity which is followed by large cap stocks which are also volatile
being from the equity asset class. The bonds which are long term are considered to be less
volatile. Also the US t bills which has been provided in other options is relatively considered
risk free and the least volatile.
Part 2: c: To calculate the Weighted Average floatation cost the target debt to equity ratio
would be used and the calculation is below,
Debt/Total Asset * ( Cost) + Equity/ total Asset * Cost
0.45/1.45 * 6.6 + 1/1.45 * 9.5 = 0.31*6.6 + 0.689*9.5 = 2.046% + 6.545% = 8.6%
Part 3: d: The current share price is calculated which is Equity/No of shares = 17800/5000 =
$3.56.
The excess cash which is available is $1000 and the share which can be bought is = Excess
cash / Share price = 1000/3.56 = 281 Shares.
New outstanding shares after repurchase = 5000-281 = 4719 shares.
Hence the earnings per share after repurchase = Net income / New no of shares = 31200/4719
= $6.61.
Part 4: c: As the risk level of the firm might be lower, hence high risk project is discounted by
lower risk. The same happens when a low risk project is evaluated using the firm beta, it is
rejected due to the high discount factor or beta used.
Part 5: b: As the optimal WACC leads to a mix of debt and equity which lowers the WACC.

Part 6: d: As per the question A has a weight of $100 while B has a weight of $300 additional
weight is being provided by $400. Hence the value of the portfolio = Existing amount + new
amount = 400 + 400 = 800.
Beta from Stock A = 100/800*1.4 = 0.175
Beta from Stock B = 300/800*0.6 = 0.225
Hence the total beta of the portfolio = 0.175+0.225 = 0.4. However desired beta is 1.1 hence
the lag in the Beta which is 1.1-0.4 = 0.7. This would be provided by stock C since the Beta
of risk free asset is 0.
Beta from Stock C = $ weight/Portfolio Value* Stock Beta = Desired Beta
Beta from Stock C = $ weight/800* 1.6 = 0.7 = 0.7*800/1.6 = 350
Hence the amount to be invested in Risk free asset is $400-$350 = $50
Part 7: a: This is due to the diversification benefits present in the portfolio which changes
with the change of weights of the securities in a portfolio.
Part 8:b:
Arithmetic mean: Stock returns / Number of return = 4%+9%+(-6%)+18%/4 = 25%/4 =
6.25%
Geometric mean = (1+Return)^1/N = (1.04*1.09*0.94*1.18)^(1/4) = ((1.2573)^0.25)-1 =
1.0589 – 1 = 5.89%
Part 9: d: The total number of shares = 300
The stock dividend = 5%
Hence the extra additional shares received by the investor is 300*5% = 15 Shares. The new
shareholding by the investor would be 300+15 = 315 shares.